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Forex Trading 101: Why Forex

February 23, 2016

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Last update: July 2021

Why forex?

A few years back, one of my mentors told me that it didn’t matter how much money I made in trading options or in business. He went on to suggest that if I didn’t protect that money I would have nothing left. While I didn’t understand the gravity of his words, the thought of losing everything I had worked so hard for and spent so much time on made me want to learn. I decided to learn how to trade forex. I now understand why my mentor said what he did as I now understand we are going through a historical change in the currency market.

A brief history of the beginnings of the currency markets

The earliest economies in human history were based on simple bartering systems wherein one valuable commodity or good was traded directly for another. Livestock and crops were most likely the earliest currency believed to be established between 6,000 and 9,000 years ago: the basic bartering system. However, it’s very limited and problematic by nature due to terrible inconsistency and general difficulty in establishing and maintaining fair and equitable trade.

Necessity being the mother of invention, more efficient systems would be established very early in our history using anything from rocks to seashells as currency. There is strong evidence that around 3100 BC, around the same time the dating of the earliest human writing systems discovered in ancient Mesopotamia, that the banking industry was established. Valuable goods such as grains, livestock, and precious metals were deposited for safekeeping around temples and palaces. Around 2200 BC, Cappodecian rulers guaranteed the quality of the weight and purity of silver ingots.

Around 1750 BC during the reign of Hammurabi in ancient Babylon, the written code of Hammurabi literally documents in stone the first known laws that govern money and banking operations. During the ensuing millennium, various models and methods of currency are adopted throughout the world. According to Herodotus, around 687 BC, the first crude coins were invented in Lydia and the first retail shops were established. By the close of the 6th century BC, the first true coins were minted in Lydia which was located in Asia Minor. The coins were made of electrum, a naturally occurring blend of gold and silver. The Chinese at some point during this same era also developed coins made of low-value base metals. In the 5th Century BC, the use of coins spreads from Lydia to Greece.

During the next several hundred years, the Persians and Greeks used this newly established and highly portable form of currency to wage war on each other. Romans showed up to the party a little late and were still using heavy and cumbersome bars or bricks of bronze and other precious metals until midway through the 3rd century BC. The use of coins was adapted by Rome by the second Punic War between Rome and Carthage from 218 to 201 BC; the demand for coins to pay for troops was so high rulers decide to debase the purity and weight of the coins in order to stretch the available supply, and as a result, inflation was born.

During the 1st century BC, Julius Caesar invaded Britain and Celtic tribes also adopted the minting of coins. In fact, the expansion of the Roman Empire helps proliferate the use of minted coins all throughout Europe. Sometime shortly after Julius Caesar uttered the Phrase et tu, Brute, Caesar August reformed the struggling Roman monetary and tax systems and issued the first known coins of differing monetary value. Precious metals were used, including pure gold, silver, bronze, and copper.

For the next 300 years, the Romans continued to tinker with money by altering and manipulating the weight and purity of the coin. Increasing and decreasing the amount of precious metals used to mint the coins could alter the perceived value of the coin. Diluting the amount of precious metals used debased the value of the coin in two different ways: increasing inventory, and reducing the quality. Because of this manipulation inflation levels fluctuated and at times soared leading to rebellions and revolutions.

Fig 1

In the year 306, Constantine secured control of the Roman Empire and removed the old currency from circulation and replaced it with the Solidus, whose weight and purity remained unchanged for the next 700 years. In 313, Constantine adopted Christianity, and following his conversion, proceeded to confiscate the enormous treasures amassed in the pagan temples within the borders of the Roman Empire. As a result, Rome and the Catholic Church accumulated massive amounts of gold bullion. Even though Constantine stabilized the Solidus, he continued to produce coins from debased silver and copper called denarii, despite having plenty of bold bullion to produce higher quality and more valuable coins. As a result, over the next 20 years, inflation for the denarii rose 300% and created huge disparity between the rich and the poor. Finally, in 410 Rome fell to the Visigoths and the Roman banking system failed. Roman banks and coinage were abandoned until the Crusades began nearly 600 years later and stimulated the re-emergence of banking in Western Europe.

Although many historians believe the reserve system dates back to the ancient Greeks with the issuing of the silver drachma, it was the Romans that widely moved it into an international system. The definition of a reserve system is a foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are usually priced in the reserve currency, causing other countries to hold this currency to pay for these goods. Holding currency reserves, therefore, minimizes exchange rate risk, as the purchasing nation will not have to exchange their currency for the current reserve currency in order to make the purchase. In essence, what the reserve system does is force other countries to hold the reserve currency to aid debt and trade in the international markets. While there have been many reserves in history such as the Greeks, Romans, Byzantine, Arabian dinar, Florence fiorina, the gulden, and Spanish dollar, it was the British pound in the 19th century that started the traditional system we use today where central banks started issuing debt that could be converted into gold.

The forex market is a directional market

The forex market is what we call a directional market, this is also known as a speculative or delta based market as well. It is similar to that of the stock market where you either long or short the stock and make or lose money based on the entry price to the exit price. It is the largest, most liquid market in the world and one where everyone participates in it, even if they don’t realize it.

For example, when James Bond travels from London to New York, he’ll have to exchange his currency, the GBP, for the USD to buy goods and services in the United States. This is the same thing we all do when we travel from any country to a foreign country. The forex market is the exact same thing: we simply take one currency and exchange it for another. Profit or losses are made from the entry price to the exit price depending if the currency goes up or down. It is also important to note that you can buy or sell any currency.

One thing that is different is that currencies are not traded as a single currency, but as a currency pair as you are exchanging one currency for the other currency. There are major pairs, cross pairs, and exotic pairs. We primarily focus on major pairs as those pairs include the USD, as it’s currently the reserve currency of the world. However, we will also trade cross pairs as there are some good carry trades involving the JPY due to its long standing low interest rates and current Abenomics policies. A popular carry trade is to sell the JPY and buy AUD as the Australians typically have higher interest rates than Japan.

The value of a currency is largely based on pure supply and demand, making it a true market with smaller manipulation that other markets such as the stock and bond markets. Typically, the value is based on the fundamental strength or weakness of the home nation’s economy, central bank monetary policy, and in the case of Canada and Australia, it can be based on the value of basic materials due to their nation’s strong reliance of producing raw materials.

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7 Replies to “Forex Trading 101: Why Forex”

  1. timzapf says:
    May 28, 2015 at 5:15 pm

    Thank You!!!
    I love this idea of step by step video series
    I have always wanted to learn forex
    Thanks for all the hard work you guys do

  2. Fidelserrano says:
    May 28, 2015 at 6:51 pm

    really good

  3. Khurshed Birdie says:
    June 18, 2015 at 8:55 am

    Great presentation Matt. Looking forward to the next chapter.

  4. BrianFuller says:
    August 31, 2015 at 1:45 pm

    Cool Article!

  5. STEWGILGIS says:
    December 8, 2015 at 7:23 am

    Excellent history report.

  6. KEITHGIUNTA says:
    February 25, 2016 at 3:53 pm

    Thanks Matt! Keep this stuff coming.

  7. OscarPaiz says:
    February 25, 2016 at 8:37 pm

    Tons of powerful knowledge. Thank you brother, looking foward to learning forex.

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